Baxter International Inc. (BAX) Earnings Call Transcript & Summary

All right. I think we're ready to get going here with our next session here at Goldman Sachs Healthcare Conference. I'm Amit Hazan, the medical technology analyst at Goldman, and we're really excited for the next conversation. We've got Baxter with us today. We've got both Joe Almeida, the Chief Executive Officer with us; and as always, Clare Trachtman, the Vice President of Investor Relations. So first and foremost, really excited to see you live and in person doing this back again. It's been virtual with you all in the last couple of years. So really nice to see you. And not surprisingly, at this conference, a lot of the conversations have been around the macro and how that's evolving. And so I thought we would start with that with you as well and try to get through that, and then get into the business as well.

And just start with manufacturing and supply chain, the top of mind for many people. I don't know how much of an update you can give us. We just saw you at the Investor Day, and you gave a pretty good update there. But electronic components, just the state of affairs for both the Baxter business on the pump side and the Hillrom business, Joe, what can you tell us?

The supply chain has been very challenging. We've been saying that for a while, and there's 2 components to it. There is the oil and fuel, so 2 different things. They go along. But the fuel has been much more acutely impacting Baxter because it's immediately felt at the pump, and we have a large transportation component to our business. We also have been experiencing component shortages for a while. And as we think about that easing into 2023, we still have a few more months ahead of us of a tough time getting chips. And it's not only chips. It's also other supply chain pressures from other suppliers of Baxter, having disruption in their supply chain affecting us. We have safety stock, but sometimes we've got to interfere quite heavily to be able to get the product. But I'll underscore the chip shortage is something that will persist throughout 2022, hopefully, through 2023, getting alleviated due to some macroeconomic changes in a potential recession and the change of demand in consumer goods, which are the biggest drivers today of chip consumption. They are not the same chips all the time that we use, but they're made. Foundry has -- foundries for chips have limited capacity as well as manufacturers. So it's how they create a mix and how they start a run of those products, and it takes a long time to get them in our hands. So we've been working very hard with our suppliers. We're doing the best we can, but the situation is difficult.

Yes. And like you said, you've talked about it, especially on the Baxter side. And we've gone through this with you, and you know your business well. On the Hillrom side, that's more new to you when you took over at the end of last year. Talk to us about the state of affairs of the supply chain there. Is it much different than what you saw in the Baxter pump side? Is it worse, better?

It is difficult as well, primarily what we call Front Line Care, which is the former Welch Allyn business. The business, which is more traditional Hillrom, the beds, there's a little less pressure on the component side, but there's more pressure on the Front Line Care.

Okay. Okay. So sticking with the theme, you're planning a $650 million value improvement programs. You've got the value improvement process for cost reduction, but you've got inflation out there and driving cost up for suppliers and labor is higher. How do you cut costs when all other costs are kind of going up? Or difficult to say?

Remember, we are putting those programs in place to try to offset the input costs that are coming much higher. So we're not -- as we said, we're not going to 100% be able to offset. But what we're doing is automation. It's a big component of what we're doing. The second is material utilization, so reduction in mature usage that may go to waste, getting processes improved. This is a big part of our cost program. So suppliers, by helping us with raw material improvement, utilization and automation, reduction of labor cost.

Okay. Okay. And so -- the other part of this is, you mentioned this at the Analyst Day, which is the idea of how the supply chain is changing, how you react to the current environment, whether it's inflation, whether it's a chip shortage. I think you're talking more and more about, hey, the old way was we developed manufacturing, where it's cheaper, maybe whether it's tax savings. And now you are thinking a little bit differently, I think about it. Maybe just talk through what changes you're thinking about that go beyond the short-term pressures that we're seeing for your supply chain?

So the philosophy is always make where you sell, buy where you make. So that philosophy will guide us in the future in where to relocate plants to and how to alleviate some of the transportation issues. If you recall, the acute crisis on transportation goes back to the Suez Canal when a ship got stuck there, and we start having issues getting products across the globe. So you fast forward, despite the fact that got alleviated, you have upcoming longshoremen in, not too far from here, in Long Beach, California at the Port of Los Angeles. You're going to have negotiations between union and the operator of the port. They may cause a strike. So you always have this fragility that you, as a company, cannot avoid. So how do you prevent that is to maximize the locations versus putting the plants where the labor may be the most advantageous or tax rates may be the best attraction. Now the attraction for us is be able to attract labor in the right place to make the product and attract suppliers to provide us with products there. We have a significant amount of suppliers transporting products from across the globe. We are moving as fast as we can. And these are not easy changes because they require relocation, qualification, validation of plants, reregistration of products. So this is a long-term program. For now, what we need to make sure is our control tower knows where the products are and understands actions before problems exist. So taking action before the problem exists. It is really challenging. At the moment, our transportation folks are working very hard.

Is it explicit in kind of this evolution that there's an incremental cost to this as well that you have to bear, given that you're kind of moving away from that old to the new? And is that incorporated in your thinking of the puts and the takes that you put into place there afterwards?

They were. They were incorporated. When we gave the -- as projections have is a net of cost reductions that we have that will have cost increases in some areas and cost reduction in the others. It is very important to underscore that a great deal of pain is now due to supply changes -- supplier challenges in chip manufacturing supply to us or to the industry as well as the fuel cost. You need to think about what is the effect of 150 barrels of oil in this whole thing as well as how to cut through the short term and possibly midterm to have a successful long-term viable business. It is to not lose sight of the 3 areas of short term, mid and long. So we don't long -- don't miss the long term because you have significant challenges in the short term. You've got to balance the investments, balance the decision, so you have altogether a good ability to meet your long-term objectives.

Okay. Okay. So let's hit inflation, too, just for a couple of minutes, and we'll move on from that. Really similar line of questioning. I'd love to hear a little bit about what your own inflation expectations are as you think about the next year or 2. And really, I'm asking the question, we're obviously going though what we're going through the near term, but how that impacts your own planning, your strategy as you think about the next year or 2? Is that impacting -- clearly, we'll get to talk about price as well and whether you're starting to get a little bit more aggressive there, but other structural changes that are going on because of inflation beyond this near-term challenge.

The inflation that hits us, hits us in labor cost, transportation cost and cost of raw materials. If you have 8% to 10% inflation, your raw materials will go up, cost of electricity will go up. So this whole combination brings us to higher input costs into Baxter, and hence, the ability to -- the necessity, not the ability, but the necessity, therefore, the ability to reduce cost to offset some of that. The inflation in labor has been particularly difficult for 2 reasons. It's not only the inflation, but it's also availability of labor and turnover. I think was very prevalent during the first quarter when we saw Omicron come in, and a lot of people were not showing up to work, rightfully so for being sick, but also the cost of retaining employees for the long term. I'm not talking about management, I'm talking about direct labor. That is the inflationary cost. We can always control the SG&A with headcount and how we hire. But at our plants, our quality groups, we never, never, never have any reductions there. So we will have exactly what we need to provide, the patient safety and quality first. So the inflationary cost hits hard there. Raw materials, the same thing. So what we do is try to offset that what. So what Jim Boris had presented during the Investor Day is designed to offset, not all, but a great majority of it.

Okay. Okay. So let's talk about price a little bit inside of this discussion. And I think it's interesting that some people think about medtech, and they think, all right, there's about a 100 basis point headwind a year for the last 10 years. That's kind of normal for medtech. I'm not sure that, that's your story, if you kind of exclude pharma. So I wonder if you could just give us a little bit of color on the impact that you've had from pricing over the last 5 to 10 years. And then just talk to us about your ability to take incremental price now given the inflationary environment.

Well, when I got to Baxter, we already had contracts in place with price increases in the first year or 2 that I was here. We had actually positive pricing despite the facts -- despite the fact that mix also helps as well as volume. Since then, you have a pharmaceutical pressure in pricing. Pharmaceutical injectables has actually driven our price mix down with erosion of pricing because the competitiveness of the market. Then when we came into the pandemic, in the sports world, where we have so much input cost increase, we're able to obtain some price increases. But that is not the norm. We did this in a way that was necessary because input cost, it did not offset the headwinds at all. Did some, but not totally. And it is something that we don't comment in specific decisions on pricing. Pricing is a very specific thing that is done. It's market forces drive price. So competition drives price down, rightfully so. So we will always be competitive to the market to maintain our business to some extent. So the reason and the need to increase prices recently in some of our markets was because the input costs were so high, and we're trying to offset some of that, so we did. But Baxter had a history of price -- positive price gain until we got into this point. I would say, probably '19 onwards, Clare?

Yes.

It was probably when we start seeing pricing start to go into the erosion territory, driven primarily by pharmaceutical, driven by long-term contracts of solutions, which we welcome. We prefer to have long-term contracts with some price erosion. And then now we still have price erosion, driven by pharma. We've got a little bit of price increase, as I said, not sufficiently to offset the input costs.

Okay. I want to kind of transition this to just talking about margins and margin aspirations. I feel like it's probably appropriate in the context of some of these macro challenges and costs. And I went back, I looked at your 2018 Analyst Day, and the guidance at the time was 23% operating margin by 2023. And different world, obviously, when we were talking back then. But if we compare it to your new guidance, at least 75 basis and basically annual $350 million to $400 million through '25. And it roughly implies about 22.5%, 23% operating margin by 2025. So it looks like the 23% in '23, we're going to be off by about 300 basis points from that old '18 guidance, basically. And again, you also have the Hillrom synergies in there, but it's a lot of, I realize, change. I think what investors want to know is we're pretty far off from the last one. Clearly, the world has changed. But how do they get confident in this new guidance, and that you've included these new factors that we have in the world to get there at this time?

Well, I think we were very specific when we presented of the assumptions that we made. We're also very specific about the cost reduction opportunities that we had. We're very specific about the synergies from the Hillrom acquisition. So when you put them all together, the result is what we presented. When we go back to the assumptions -- because the assumptions were clear about the trajectory of cost of oil, or price of oil, rather, the assumptions are very specific about the lack of a recession in our numbers and other things. So I urge you to go back and read those assumptions. Also, we were very specific on cost reductions, where they're going to come from and the synergies. So when you put it all together, we came up with the long-term guidance that we present to you.

Okay. Let's talk about the Hillrom synergies, $350 million. You took the guide up, which is great to hear, so soon. And you said it's because you're doing better than originally anticipated, great to hear. You didn't change the '22 number. So I'm wondering what's happening that gives you confidence in the medium term for the Hillrom synergies, but not yet for the current number?

Just -- we had increased the '22 number already. So the original '22 number was $75 million, and we had already increased that to $100 million. So we were tracking ahead of that already.

Okay. Okay, fair enough. Let's spend a second on hospital CapEx. Just remind people what hospital CapEx is as a percent of total. And then, if you don't mind, just how you're thinking about it, hospitals, if you're having conversations. A lot of investors are starting to have those conversations starting to think about what capital spending looks like for hospitals over the next 6, 12 months.

I'll say, CapEx, probably...

10%.

I was going to say about 10% of our total sales. We're starting to see smaller hospitals waiting to see what the recession or the situation of the capital markets are going to take them. So we're starting to see some postponement orders in the capital equipments market.

Okay. Let's talk about new products. This was something pretty exciting that you guys shared at the Analyst Day, expected to contribute $800 million incremental to 2025 revenues. I don't want a specific breakdown, but I'd love to hear you, just kind of see what comes to your mind, the buckets that are in there that you're most excited about. Is it connected care? Is that the biggest category? Or just talk through, when you hear that number now that we're a couple of weeks past the Analyst Day, how do you think about where that contribution is coming from.

Well, I think the first and foremost, I think medication delivery, infusion systems is the exciting area. Due to our new portfolio of products, we hope to start launching this year, towards the end of the year. We also have a significant amount of new molecules that we think will help us continue to offset some of the trends in the Pharmaceutical business. I do like our Front Line Care portfolio. I think that portfolio is really rich, even richer than we called our rest of Hillrom, which are the beds. And with the exception, I think, the connected care, connected health, which is simplified by Voalte and other applications. So also the expansion into the patient -- into the home care and the physician's office. So it's Front Line Care product line, which is very attractive, our new infusion systems pipeline, some of the connected care that we have under Voalte, some of our expansion of our Bardy monitoring -- cardiac monitoring systems, just to mention a few. And some of the molecules that are coming out to be able to offset some of the price erosion that we have in pharmaceuticals. This are just to top-of-mind interesting products that we have.

Yes. Okay. So a couple of follow-ups there. I mean, obviously, connected care, a very exciting part of the acquisition. Other companies talking about it as well. There's clearly something there. This is going to be a good market for medtech, it seems, over the next 5, 10 years. But given some of your other markets here, you say it should grow high single digits through '25. How big is connected care now already for you? And when is kind of the first dollar of incremental revenue going to be realized from this combination?

Well, we do have about $200 million, $300 million in sales in connected care.

Of care -- like care communication products. Yes. Yes.

Okay. Care communication products, and we hope to multiply that a few times in the next 5 years. And that will come from connecting products amongst ourselves, but also to launch new products that we have in both -- in all the business, with exception of Pharmaceutical. And we have one product with connected care, in Advanced Surgery, which is to connect nerve terminations and vessels that looks at impedance, which is a good product. But it's a lone product in Advanced Surgery in a $1 billion market, $1 billion sales, as a matter. Everybody else has connected care. So the next generation of PD cycler, which we didn't present details, our project is fully connected. Our -- today, our Sharesource, the evolution of Sharesource software from managed people home, that is connected care expansion and Voalte, connection of Voalte with infusion pumps. Infusion pumps themselves are connected products. Our CRT devices have predictive analytics on them, that is connected health. So there's not a product that we have that does not have -- does not touch their market. So we've been -- we'll continue to invest and have wins.

Yes, makes sense. And just a quick follow-up on Voalte because that does come up a lot and also seems very exciting. Just help to position this one. Revenue, if you can talk a little bit high level where that is. Penetration of the opportunity, market size, how much color can you give us on that specific opportunity?

Voalte?

Yes.

Voalte is a product that is -- has tremendous opportunity for penetration and for association with other products of Baxter. As I said, you can associate the pumps, link the alarms, CRT alarms to it and become more relevant. But there's also new versions of the product and other characteristics that we want to bring to the market. So Voalte is a great platform for us. It was a great acquisition made by Hillrom, and we want to capitalize on that.

We haven't disclosed the sales, specifically of Voalte. It's part of that care communications number, which is around that $200 million to $300 million. So we also have a nurse call in there and products like that.

Okay. Okay. Let's keep moving and go to med delivery. And market growth expectations for you were lower to 1% to 2%. You want to just remind us what was behind that?

So the medication delivery, in terms of the overall market growth, that's really just driven by our expectation that there's some new capacity coming online towards the latter part of our long-range plan.

By competitors.

By competitors, yes. So some of -- there will be new entrants into the space or increased capacity. And as a result, we would expect some impact on the overall market growth during that time period.

Okay. Okay. And the compulsory question of NOVUM. And just the latest update, interactions, timing, if you have any?

We are working on one specific issue, 1 or 2 specific is that we have. We are somehow confident that we can get those addressed to the satisfaction of the agency. We don't speak on behalf of the agency at all. And so our expectations that we can do the best we can to address that, and I think we can. And we then will submit again towards the end of the year, and we'll have then an answer. It's a good product. I'm excited about that platform. We actually have our syringe pump was submitted in the month of May. So we will see probably 3 more weeks, where we stand with that. And we will do -- we'll continue to proceed after if we're successful launching those 2 products this year. We then go into the PCA and ambulatory in the future.

What's your sense of market share during this COVID era for you? What's market share been for pumps in the U.S.? I mean, has it changed much?

It changed. It went up because...

For Baxter, yes.

For Baxter.

Yes.

I'd tell you, if I had more components, we'll be able to sell more pumps. Unfortunately, we don't have as many as we need. So we continue to have good acceptance of the current product, the SIGMA SPECTRUM, on the market, and we continue to grow that business. We went up probably to probably 25%.

A couple of points, yes.

25% market share?

Yes.

We'd say about 25% market share based on our analysis, our analytics. And hopefully, with the new pump, we'll be able to make more inroads.

Okay.

Okay. And that's just specific in large volume pumps because we don't currently sell a syringe or the PCA pump today.

Yes. So let's touch on renal for a second and maybe hit the mortality issue first. I don't know how hard this is to model. It seems like it's very hard to model. So tell us what you think now in terms of when that kind of goes from being a negative to potentially positive.

Well, as you all know, there was significant mortality of ESRD patients on therapy during COVID. They are the most fragile -- one of the most fragile populations at that moment. So what we're starting to see, we're starting to see that in -- the PD volume picking up. We see the market, like we said, 5% to 6%. I think the U.S. would be an 8% to 10% market when things normalize and the effect of the AAKHI. AAKHI kicks in and up in terms of incentive for the home therapy versus in-center. So if you know, there's their phases of rollout, and the phases have different incentives for putting patients in the home. So we think it's a great market for Baxter to be in, and we're looking forward to continue and support our partners in that. We had put some capacity in place to be able to support the volume. And we will continue to make investments as we see fit.

Yes. So the shift to the home, and more specifically talking to the cadence of growth or when this really takes off, what's your sense of how close we are to that happening?

So I think once we get through this reduction in the patient census, the penetration, probably there's a different -- I have personal expectations. Clare has her personal expectations for penetration. The number that the government to achieve is very high. We want to probably look more now get to 30%, 40%, perhaps 50% of that demonstrated -- the demonstration pool.

Okay.

Yes, exactly, of the 1/3 of the population is part of that.

1/3 of the population, 50% penetration. So you've got to read the AAKHI. So it gets a little, not complex, but has a lot of caveats on the calculation.

Okay. TERRANOVA, you touched on at the Analyst Day, just maybe get a quick update there. And just we're trying to handicap. I know this is out of your area and into the government, but how do we think about expectations for reimbursement there?

Well, we want to be optimistic. As I said, we don't speak on behalf of the CMS. We don't speak on behalf of any agency, anything that's outside the 4 walls of Baxter. We respect their decision. So we are coming out -- probably we'll know something more during the month of July about the status of the application for an add-on payment, which was, as you know, was not -- didn't go through the last round in 2020.

Yes. And so the final rule will be in November. But we did not include any expectation of positive reimbursement in the long-range plan guidance that we provided at our Analyst Day.

Okay. Terrific. Well, let me kind of interject a question about China here because it might tie in to renal. But this is a broader question, just for the Baxter business we're talking about it at the breakfast a little bit today. Just thinking about the changes that have happened there, medtech looks at China a little bit differently today than we all did maybe 10, 15 years ago. How do you think about China in the near and medium term for Baxter?

China is an attractive market for Baxter, primarily in peritoneal dialysis. We have a very large market share. There, we were pioneers. We make the product in China, for China. We don't import solutions into China. We have factories in China to make the product. I think there are changes in the reimbursement system. I think China wants to reduce the total cost of health care. So they have the value-based procurement as well as the made-in-China aspiration, which actually has become more than an aspiration. So the VBP is a reduction, is a clear design for introducing -- reducing price. Baxter has not a device in PD. Baxter has a system, has a therapy, which has different solutions with different prescriptions for the everyday management of the surgery patient. And our support is extremely important. So I think that's how we present our products as a therapy, not a specific one product like an implant or something of the sort. So the VBP is here to stay. It has different impact in many different companies. I think the impact for our business in Baxter, it has reduced our growth of PD business. You can see in our projections in our long-range plan because the reduction of price and sometimes volume in China as we may decide not to participate in every provincial tender for value-based products. So value-based procurement, VBP. so I would say that VBP will affect Baker is already factored in the numbers that we presented as LRP, but it's still a great attractive market. So we can -- we made significant investment, wherefore decades in China behind PD, we are the PD company in China, so we continue to have a full commitment to enhance our participation by providing more options for patients and provide an excellent therapy and partnership with the patient.

And what we see in the pricing dynamics across the board in Medtech, it doesn't change your view on how to bring the rest of Baxter into China over time?

Well, for the rest of Baxter, we need to be able to bring manufacturing into China for some of the products. And this final assembly, you've got to do it. There's specific rules above that. And we're evaluating right now, primarily for Hillrom, because they had plans to be there, and that made in China reduced a little bit their capability to do it immediately. So we're looking at how we're going to do that.

Okay. Okay. We've got a minute left. We close on capital allocation, as we usually do. And just ask you about both M&A, you kind of spoke about strategic bolt-on potential, just what areas make sense. I know it's hard to talk about publicly just rough high level, how you're thinking about M&A and then the divestiture side, too, which you talked about, just maybe -- I don't know if you can talk to realistic size ranges or what kind of color you can add to your thinking about potential divestitures?

So let's make sure that the capital allocation is always we're going to pay our debt first to a level that makes us comfortable, and that we're going to engage in M&A. Refer to our presentation at the Investor Day. We have a specific that page talks about areas of interest. When you speak about divestiture, I would say the strategic aspect to the business of a certain business of ours, its ability to be profitable and grow above market. And actually, the weighted average market growth rate for that specific business, okay, or the growth rate for that business, that makes the attractiveness. At that moment, we'll make a decision whatever ranks lower. We make a decision what we do with those businesses. And we actually will be announcing later this year our decision on a couple of businesses that we want to divest.

Okay. Okay. Well, let's end it there. And Joe and Clare, great to see you in person.

Thank you.

Thanks you for being here.

Thank you very much.

Thanks, everyone.

Thank you so much for having us.